Swiss market liquidity: Anything left to drink?

In The Rime of the Ancient Mariner, Samuel Taylor Coleridge was not discussing equity trading, but his words are relevant when looking at current market liquidity and trading conditions. Are these risks still present, and is there anything that can be done about them as we approach 2017?

According to Deloitte, there is over $2trn (€1.8trn) of offshore wealth held in Switzerland, which makes it the country with the greatest offshore holdings, at 21.7% of the global total. Combining this with the assets of local Swiss pension funds, around €737bn, Switzerland has a large voice when it comes to trading and market issues. This article will discuss market liquidity using a definition put forward by IPE last year – “the ease with which an asset can be bought and sold”. Specifically, it will look at trading behaviour on the Swiss exchange equity platform and how this can present a view not just of the liquidity issues facing investors, but how some are finding ways to help mitigate problems.

The Swiss equity market is diverse with different liquidity profiles and instruments. There are a number of instruments where finding large volumes of liquidity and moving relatively large positions is possible through intelligent trading.

We continue to see significant liquidity across the main Swiss exchange SMI index. This allows investors to trade large volumes of stock directly in the market with minimal price impact. There is clearly no liquidity problem in these main blue chip instruments for the vast majority of

investors. This pattern repeats itself across Europe as the largest blue chip shares continue to be easily available to investors. This is visible when looking at the Spread Weighted Liquidity in SMI instruments through the month of August 2016 (figure 1). The liquidity available within 50bps of the top of book is significant across the index peaking at over CHF9m (€8.3m) on SIX Swiss Exchange at the end of August.

Robert Cranston

So the challenge across Europe is in less heavily traded instruments. Here, the issue is finding liquidity rather than the price. With an increasing search for yield and alpha, investors continue to push into a wider range of asset classes, which means finding liquidity in smaller and less traded instruments a higher priority.

The question is, therefore, what can be done by Swiss pension funds and others to address this challenge? The answer for a number of them, both asset managers and those trading directly, is yes. Many firms are changing the way they operate in an attempt to improve their ability to find liquidity across the markets.

If we look at the service offerings of SIX Swiss Exchange, and specifically at how the usage of these services has changed, we can see that there are a number of distinct adjustments being made by members to try and help them find additional liquidity using existing connections and trading systems.

A good example is the increased use of iceberg orders. The exchange introduced these in 2014 and since then has seen an increase in their use, with members looking to trade large positions of less liquid instruments without revealing their entire position to the market. Feedback has been consistent that when dealing with less liquid instruments, where information leakage is a significant risk, use of iceberg orders can reduce the risk of adverse execution quality when completing larger orders.

In August 2016, which was seen as a slow trading month across the equity market, the use of iceberg orders picked up considerably, which could show an increased usage of the order type as liquidity further erodes.

Another change in behaviour that we have seen is block trading, a service launched five years ago. Over the past year, we have seen an increase in its use. While we expected this for remote members within the European Union, who are dealing with the direct impact of Markets in Financial Instruments Directive (MiFID) II, there has also been an increase in discussion of the service in Switzerland both from pension funds and direct traders.

We believe this is down to on-going Europe-wide issues with liquidity in less heavily traded instruments, and members looking for additional sources of liquidity within the safety of an exchange-regulated trading venue. We continue to see large value gained by members using SIX Swiss Exchange’s partnership with Liquidnet both in terms of finding sources of liquidity, and execution price improvements available in trading volumes that are not available on the order book itself.

We have also launched a mid-point non-display pool on our main trading platform to further help members find liquidity. The exchange is hopeful that this will provide another service for trading members to be able to find liquidity while minimising information leakage.

There is a thread to all of these initiatives, which is an increased use of technology to help firms deal with the diverse and changing sources of market liquidity.

Technological innovation has been at the heart of the Swiss equity market for over 20 years since it started its migration to a fully electronic platform. In that time, the pace of change has only accelerated, as have the offerings available for pension funds and others looking to execute equity orders in Switzerland and across Europe.

Swiss institutional investors need to continue to adapt to new and improved technical solutions to ensure they are able to access the liquidity they seek. As market operators continue to offer more solutions to help optimise the search, they will require smart and agile partners to avoid missing out on liquidity and the new ways in which it is presented to the market. This will take serious effort and analysis by everyone in the execution chain.

Robert Cranston is head of equity product management at SIX Swiss Exchange